How working tax credits can offer limited company contractors extra protection

As a contractor, taking realistic measures to protect yourself against periods of low income goes with the territory. Although contracting offers many advantages and lucrative opportunities, it can also be unpredictable. Contractors can spend time out of work between jobs, while their rate can often be affected by fluctuations in market demand. In addition, limited company contractors aren’t entitled to statutory benefits such as sick pay and maternity pay, which means that unforeseen periods of time off can have financial repercussions for contractors who don’t think ahead. With changes to IR35legislation causing shakeups for limited company contractors, ContractingWise looks at how making a protective claim for working tax credits could be a prudent means of safeguarding your income.

What are working tax credits?HMRC’s tax credits are a means-tested benefit designed for workers on low incomes and individuals with children. They were introduced in 2003 as an incentive for people to remain in employment rather than claiming benefits. Tax Credit claims are based on your individual circumstances and can be made by freelancers, contractors and directors of limited companies.

Protective claimsIncreasingly, tax experts are encouraging contractors to make what’s known as a protective claim with HMRC. Even if your income is too high to qualify, by filling in the paperwork each year your information will already be in HMRC’s system. This means that should your income fall below the £6,420 threshold because of unintended time ‘on the bench,’ unforeseen circumstances or the birth of a child, you’ll be eligible to make a claim immediately. In order to make a protective claim contractors should fill in the paperwork by the 31st July deadline to ensure they stay in the system, as claims can only be backdated by three months.

How do I qualify for working tax credits?There are two types of tax credits and contractors meeting all the criteria can claim for both.

Working tax credit: To quality for working tax credit a contractor must be working for at least 16 hours per week and be on a very low, or no income. Although limited company contractors between contracts may be concerned that they’re not working enough hours to be eligible, they’re still working for their own limited company, rather than a client. Searching for the next contract opportunity, networking, checking job boards, applying for assignments and admin tasks like bookkeeping are all qualify as ‘work’.

Child tax credit: This is payable to parents and guardians who are responsible for a child. Since 6 April 2017, most people can only get the child element of child tax credit for up to two children, although you’ll still be able to claim it for more than two children if they were born before 6 April 2017. Those guardians or parents on higher income may still qualify if they have more than one child, childcare costs or a child with disabilities.

How much tax credit will I receive?Calculating the amount of tax credit you might receive is highly complex. The precise sum is determined by your income, which includes dividends. A lower income will receive a higher tax credit. Firstly, your living status needs to be considered. If you’re living as a couple, you’ll need to make a joint claim based on your household income. Disability, age, hours worked and children are all other factors that determine the qualifying bracket for a claim and how much you can be awarded. Contractors can gain an estimate using HMRC’s automated calculator.

Having said this, if you strongly believe that you’re entitled to credits and HMRC turns down your claim, it’s definitely worth persisting and getting an adviser to back you up rather than backing down at the first hurdle.

What to avoidAlthough protective claims are not looked on unfavorably, regardless of your income, there are certain factors to consider if you don’t want to end up on the wrong side of HMRC:

Inform HMRC of any changes in your circumstances; failure to do so can result in you having to payback any overpayment in a lump sum and may also result in your benefits being withdrawn

Limited company contractors shouldn’t attempt to adjust their income to gain entitlement to a higher tax credit while keeping their profits sitting in their company, as this is against the law

Limited company contractors will need a contract of employment to claim credits. This means that you’ll then fall within the National Living Wage legislation; remember that the low salary, higher dividend policy to extract funds from your limited company tax efficiently can be affected by the salary level you take.

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